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Rearguing the Great Depression, University of Chicago Style

photo: Wikimedia

In the wake of the Great Depression, classical economists argued that unemployment was due to unwillingness of labor to work for the wages on offer. It is unimaginable that those people we see in old black and white pictures near starvation, traveling around looking for a job, wouldn’t take whatever wages were available. John Maynard Keynes took several pages in The General Theory of Employment, Interest, and Money to debunk it. But foolish economic theory never dies. Casey Mulligan resurrects it in a recent paper, with a 21st century twist.

Mulligan is a University of Chicago economics professor, who writes for the New York Times blog Economix. He would be a great example for the sequel to Yves Smith’s book, ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism. This is from the abstract of one of his papers published in February 2009, What Caused the Recession of 2008? Hints from Labor Productivity:

This finding suggests that a reduction in labor supply and/or an increase in labor market distortions are major factors in the 2008 recession. The decline in aggregate consumption suggests that the reduction in labor supply (if any) is neither a wealth nor an intertemporal substitution effect. “Sticky real wages” or the emergence of significant work disincentives are possible explanations for these findings.

The point of the paper is this (p 7-8, fn omitted):

In other words, the labor supply distortion not only prevented an increase in labor that would have been consistent with the consumption drop, but actually reduced labor. In this sense, the labor supply distortion is responsible for more than 100% of the employment decline since December 2007.

“Labor market distortion” means anything that keeps wages above the level that would be set in the absolutely free market. It includes unions contracts, minimum wages, rules that restrict immediate plant closings, costs of and other restrictions on moving to take a job, and the host of rules and regulations that offer protection to workers.

Keynes pointed out that this theory is contradicted by the real behavior of workers, who aggressively seek work of any kind and at any pay level. Keynes, who lived in the real world, would make the same observation today, watching people take jobs far below their qualifications and experience, and reading reports about real people, like this one from USA Today.

Mulligan goes farther, though. He argues that some workers choose to work less to get a mortgage modification. This paper was published in February 2009, and written earlier, so it isn’t fair to point out that these programs are a total bust. But please. Working less so you can get a small reduction in your interest rate? If you have a job, you can refinance to get that lower rate. If you quit working, you lose everything. If Mulligan looked at the real world behavior of humans, he would see that people do everything they can to hang onto their homes. He would realize that there are no workers who can set their schedules to give them the precise number of hours to earn the exact amount necessary to qualify them for a mortgage modification.

Another benefit for not working cited by Mulligan is that the IRS is more lenient on financially struggling families. In the real world, workers pay their taxes through withholding. I saw thousands of workers who filed bankruptcy, and only a tiny number owed any taxes. Unpaid taxes were only a problem for a few small business owners.

Mulligan’s real villain is “means-tested benefits”, that is, money going to people based on their financial situation, usually income. He is arguing that unemployment benefits are keeping people from taking jobs.

Mulligan reaches these insights through mathematics. He begins with this definition in the form of an equation:

yT =(AT/nT)0.3

where y is output at time T, n is labor input at time T, A is the residual number necessary to make this definition work, so it represents a group of other determinants of output, and the exponent 0.3 is derived from factual data. All of his charts are based transformations of this equation, together with other basic economic equations.

Apparently Mulligan wrote this paper without doing a reality check. Are there people who went to the boss and asked for fewer hours so they could get a mortgage modification? Are there people who quit their jobs so they could avoid their taxes? These people only exist in Chicago School equations.

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